Hedging with gold: Could investing in gold make sense for you?

Given that the value of gold doesn’t typically follow the same ups and downs of other asset classes, such as stocks and bonds, gold can provide an important role in portfolios diversification.

Gold’s ability to act as a “store of value” can help mitigate risk during times of market volatility and economic uncertainty. It may also be able to act as a hedge against inflation. In addition, gold historically has exhibited an inverse relationship to the US dollar, meaning as the dollar weakens, gold prices tend to rise, potentially making it an interesting investing opportunity.

So how can investors add gold as a practical matter to their portfolios? Below are three potential ways to invest:

1. Physical gold: The most obvious way to invest in gold may also be the most complex. Buying gold bars and coins—also called “bullion”—requires delivery and storage of the physical asset, which is often facilitated by a third party and subject to fees.
2. Stocks: Alternatively, investors can get exposure to gold through stocks of companies that mine for gold. One thing to note is that gold-mining companies tend to be more volatile than physical gold. Typically, the mining sector correlates with the price of gold, but individual stocks may face country—and company-specific risks.
3. Funds: Mutual funds and exchange-traded funds (ETFs) also offer investors exposure to gold—through baskets of securities that invest in gold-related assets. For the pure-play funds that own the metal, their value tracks the price of gold. The fund shoulders the cost of holding physical supply and passes it along to the investors in the expense ratio. Other funds might invest in multiple mining companies.

There are some drawbacks: Some gold funds are taxed as collectibles, so they don’t benefit from the lower long-term capital-gains rates for which stocks may qualify. Plus, gold funds don’t produce any income, so the expense ratio can eat into principal every year.

Even within this small sector, choosing a fund requires some homework. Some funds own companies that mine different types of precious metals; some funds are global, and others own only small- and mid-capitalization mining companies. It’s important to read the fund’s prospectus to make sure it aligns with an investor’s individual risk tolerance, asset allocation goals, and values

If the odds of a US recession rise, some investors might aim to reduce their allocation to equities, but investing in gold may also be an approach to consider. Historically, gold prices tend to rise during a recession as bond yields, adjusted for inflation, fall. Conversely, a stronger dollar and rising yields, driven by improved global growth, would likely limit gold’s upside.

While gold isn’t typically viewed as a long-term strategic investment, for some investors, an allocation to gold as part of a diversified portfolio may be worth considering. But as always, keep in mind individual goals, timelines, and financial risk tolerance.

The source of this Morgan Stanley article, “Could Investing in Gold Add a New Dimension to Portfolios,” was originally published on Nov. 25, 2022.